Industrial Policy Revisited: A pro-competitive perspective is essential
Program Director and Faculty Fellow, RIETI
In order to achieve sustainable economic growth based on the aggressive fiscal policy and monetary easing announced by Prime Minister Shinzo Abe, a new growth strategy, the "third arrow" of his economic policy, is important. With manufacturing industries such as electronics and semiconductors remaining sluggish, the industry policy that should be included into the growth strategy is being hotly discussed, even after Prime Minister Abe's announcement of his tentative plan on June 6, 2013. This article will trace the history of Japanese industrial policy and consider future industrial policy from an economics viewpoint. The term "industrial policy" has been used in various contexts in the past. At times, the policy measures of the then Ministry of International Trade and Industry were collectively called industrial policy. In economics terms, it can be summarized as "policy to address market failure associated with resource allocation."
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In particular, at an early stage of industrial development, a market may not function as expected for reasons including information asymmetry and externalities. When such market failure exists, government intervention such as industrial policy can be justified by economics. In Japan, during the post-World War II period up to around the 1970s, resources were predominantly allocated to heavy industries and other specific industries through subsidies, tax breaks, promotion measures, and administrative guidance, leading to the formation of many cartels in the textile, steel, and other sectors.
Subsequently, emphasis on specific industries in industrial policy declined significantly due to the progress of trade and capital flow liberalization and through the Japan-U.S. Structural Impediments Initiative. As the Japanese economy matured, it became difficult to draw a clear distinction between growing and declining industries and thus to formulate promotion measures to a specific industry.
Another major trend was that western countries, led by the United States and the United Kingdom, changed course and adopted deregulation and privatization policies. In order to make efficient use of limited policy resources, promoting structural reform would be effective, and countries have increasingly adopted "corporate/business-oriented" policies centering on competition policy.
Meanwhile, economic studies had a non-negligible influence on these changes in philosophy regarding industrial policy. Retrospective evaluation showed that the effectiveness of past industrial policies was not clear as was generally believed. These study results raised the question as to whether a government would be able to address market failures properly.
Furthermore, there were criticisms that (1) just as the market fails, so too may the government. Social costs associated with the latter case could not be negligible; and (2) whether the government would be able to select specific industries that should be promoted. These criticisms, with no effective rebuttal, led to increased pessimistic views about traditional industrial policy. Doubt persisted over industries that should be promoted by industrial policy but might be chosen for reasons other than market failure (such as the influence of government intervention and retiring government officials parachuting into private-sector positions), deadening interest in industrial policy worldwide.
Industrial policy has been in the limelight again since the global financial crisis that started in the autumn of 2008. Various unprecedented actions were taken by the governments of Japan, the United States, and European countries, including subsidies associated with ecologically-friendly cars and other measures to expand domestic demand in specific industries and the provision of financial support to individual companies. Given that these measures were applied for a limited period of time to prevent companies from facing difficulties due to unanticipated external demand shocks, they can be appreciated as effective to a certain degree.
However, the continued implementation of these types of measures could blur the distinction between proper measures, and those to help prolong the life of industries that should decline or companies that should exit and hold up the reform of the industrial structure. When formulating a growth strategy, the Abe administration needs to adopt an approach that is different from the emergency measures that were taken in the wake of the global financial crisis.
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Given the historical background, industrial policy should continue to center on competition policy. Unlike when Japan had lagged behind western countries, it is not easy for the country now to have a future vision of an industrial structure and growth industries, and the policy targeting a specific industry has come to a standstill. In order to facilitate rejuvenation through the shedding of unprofitable businesses or business integration, the further promotion of structural reform and deregulation would be effective. In that sense, the government's decision to participate in the Trans-Pacific Partnership (TPP) negotiations can be appreciated as the first step toward effective industrial policy. At the same time, with the conditions surrounding the Japanese economy changing dramatically, "market failure" to be addressed by industrial policy is also undergoing a transformation.
Due to rapidly developing information and communications technology and growing Internet use, technologies can be easily copied and transferred across national borders. This has raised new problems for Japanese companies, i.e., how to secure technological capabilities and profitability. Meanwhile, in emerging countries, demand for basic necessities has run its course, and added value required by each individual consumer has become diverse. As such, companies are continuing to seek business models to create new demand.
Considering the ongoing changes in the socio-economic condition, now is the time to explore new industrial policy to help rejuvenate the economy. Two important issues in view of the revitalization of the Japanese economy—the turnaround of existing companies and the creation of new businesses—are discussed below.
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Corporate turnaround is the business of reviving insolvent companies, despite having competitive technologies, by spinning off underperforming divisions. If a turnaround can be expected through debt waivers and returns exceeding the liquidation value can be gained, the business could be conducted by private companies. However, when traditional lending practices such as offering personal guarantees and placing particular emphasis on real estate collateral remain and when the private sector's knowledge of conducting the turnaround business has been lost, public-private funds can play a supplementary role for the private sector for a limited period of time.
Although it is empirically clear that the creation of new businesses acts as the driving force for economic growth and innovation, sustained efforts are needed until a business can stand up on its own. Comparing per capita venture investments among leading Organisation for Economic Co-operation and Development (OECD) member countries, Japan is close to the bottom, and it is also lackluster in terms of the number of business startups.
In order to make a breakthrough, the government should work to revitalize innovation from the perspective of both supply and demand. In terms of fund supply, it is conceivable to improve venture investments by pension funds, which are by far insufficient compared to those of the United States and European countries, in a bid to encourage private investment. In order to create demand for innovation, making more effective use of the special zone for structural reforms is more important than ever. Innovation Network Corporation of Japan (INCJ), a government-affiliated fund, could be viewed as providing individual companies with such special zones. If this fund develops successful examples, the current environments surrounding venture investments could substantially change.
There are many problems with the industrial policy approach using public-private funds. For example, there are voices claiming that public support for Japan Airlines Co., Ltd., an example of a corporate turnaround, distorted conditions on the grounds of fair competition. Behind this is that Japan's current corporate support scheme is lacking a viewpoint of competition policy.
The European Union (EU) approves of public support on the condition that compensatory measures (remedies) must be taken to ensure conditions for fair competition (see Table). A similar idea has been adopted also in Japan for merger regulations. Given that making an evaluation from the viewpoint of competition policy is effective in minimizing the negative impact of government failure, the EU's state aid guidelines are helpful when we consider a framework of public support in Japan.
There is no panacea to revitalize economic activities. In order to ensure transparency and fairness, market competition discipline should be maintained. At the same time, it is necessary to consider how public support should be provided and in what way ex-post evaluation should be conducted. A new perspective on industrial policy is now welcomed.
* Translated by RIETI.
April 2, 2013 Nihon Keizai Shimbun
June 11, 2013
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